In economics, market clearing is the process by which, in an economic market, the supply of whatever is traded is equated to the demand so that there is no excess supply or demand, ensuring that there is neither a surplus nor a shortage. The new classical economics assumes that in any given market, assuming that all buyers and sellers have access to information and that there is no "friction" impeding price changes, prices constantly adjust up or down to ensure market clearing. [1]
A market-clearing price is the price of a good or service at which the quantity supplied equals the quantity demanded, also called the equilibrium price. [2] The theory claims that markets tend to move toward this price. Supply is fixed for a one-time sale of goods, so the market-clearing price is simply the maximum price at which all items can be sold. In a market where goods are produced and sold on an ongoing basis, the theory predicts that the market will move toward a price where the quantity supplied in a broad period of time will equal the quantity demanded. This might be measured over a week, month, or year to smooth out irregularities caused by manufacturing batches and delivery schedules; some sellers may maintain inventory buffers to ensure that products are always available for retail sale and to smooth out irregularities caused by manufacturing and delivery schedules, others employ Just-in-time manufacturing to increase profits in normal operations with the trade-off being greater disruption when irregularities do inevitably occur (eg. drastic market fluctuations, natural disasters, pandemics, power outages, etc...).
The market clears when the price reaches a point where demand and supply are in equilibrium, enabling individuals to buy or sell whatever they desire at that cost. When supply and demand are equal, a market clearing takes place. The market must experience a shortage or a surplus to reach this state. A shortage indicates that buyers are interested in purchasing something, but need help to afford to do so at current prices. Conversely, a surplus occurs when there is an excess product beyond the quantity that buyers are willing to purchase at current prices. New classical economics does not assume perfect information in the short run, but markets may approach efficient outcomes as information is discovered. [3]
If the sale price exceeds the market-clearing price, supply will exceed demand, and a surplus inventory will build up over the long run. If the sale price is lower than the market-clearing price, then demand will exceed supply, and in the long run, shortages will result, where buyers sometimes find no products for sale at any price.
The market-clearing theory states that prices in a free market tend towards equilibrium, where the quantity of goods or services supplied equals the quantity demanded. The theory assumes that prices adjust quickly to any changes in supply or demand, meaning that markets can reach equilibrium instantaneously. For example, consider a scenario where a community experiences an earthquake that destroys all houses and apartments. The sudden demand for new housing will create a temporary shortage of houses and apartments in the market. However, if prices are free to change, construction companies will build new houses in the short run, while new companies will enter the house and apartment construction market in the longer run. As a result, the housing supply will increase, eventually reaching a point where it equals the new demand. This adjustment mechanism clears the shortage from the market, establishing a new equilibrium where the market is in balance. This adjustment process is critical in ensuring that markets operate efficiently, promoting economic growth and stability. This increase in production brings supply into harmony with the new demand. The adjustment mechanism has cleared the shortage from the market and established a new equilibrium. A similar mechanism is believed to operate when there is a market surplus (glut), where prices fall until all the excess supply is sold. An example of excess supply is Christmas decorations that are still in stores several days after Christmas; the stores that still have boxes of decorations view these products as excess supply, so prices are discounted until shoppers buy all the decorations (to keep them until next Christmas).
 | This section needs additional citations for verification .(January 2024) |
For 150 years (from approximately 1785 to 1935), most economists took the smooth operation of this market-clearing mechanism as inevitable and inviolable, based mainly on belief in Say's law. But the Great Depression of the 1930s caused many economists, including John Maynard Keynes, to doubt their classical faith. If markets were supposed to clear, how could ruinously high unemployment rates persist for so many painful years? Was the market mechanism not supposed to eliminate such surpluses? In one interpretation, Keynes identified imperfections in the adjustment mechanism that, if present, could introduce rigidities and make prices sticky. In another interpretation, price adjustment could worsen matters, causing what Irving Fisher called "debt deflation". Not all economists accept these theories. They attribute what appears to be imperfect clearing to factors like labor unions or government policy, thereby exonerating the clearing mechanism.
Most economists see the assumption of continuous market clearing as unrealistic. However, many see the concept of flexible prices as useful in the long-run analysis since prices are not stuck forever: market-clearing models describe the equilibrium economy gravitates towards. Therefore, many macro-economists feel that price flexibility is a reasonable assumption for studying long-run issues, such as growth in real GDP. Other economists argue that price adjustment may take so much time that the process of calibration may change the underlying conditions that determine long-run equilibrium. There may be path dependence, as when a long depression changes the nature of the "full employment" period that follows.
In the short run (and possibly in the long run), markets may find a temporary equilibrium at a price and quantity that does not correspond with the long-term market-clearing balance. For example, in the theory of "efficiency wages", a labor market can be in equilibrium above the market-clearing wage since each employer has the incentive to pay wages above market-clearing to motivate their employees. In this case, equilibrium wages (where there is no endogenous tendency for wages to change) would not be the same as market-clearing wages (where there is no classical unemployment).
In an unregulated and perfect market both labor market wages and product market prices are fully flexible and can change rapidly based on supply and demand. This flexibility ensures that neither the product nor the labor markets will experience an oversupply. If there is an oversupply of a product, its price will drop until buyers find it affordable, and in the case of a labor surplus, wages will decrease until employers can offer jobs to all willing workers. This mechanism ensures that every market tends towards equilibrium where supply meets demand. For instance, retailers may offer discounts on old cell phones and computers to sell them quickly and balance their inventory. The flexible pricing allows more people to buy these items, achieving market equilibrium.
Microeconomics is a branch of economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics focuses on the study of individual markets, sectors, or industries as opposed to the national economy as a whole, which is studied in macroeconomics.
Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study topics such as output/GDP and national income, unemployment, price indices and inflation, consumption, saving, investment, energy, international trade, and international finance.
In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In theoretical models where conditions of perfect competition hold, it has been demonstrated that a market will reach an equilibrium in which the quantity supplied for every product or service, including labor, equals the quantity demanded at the current price. This equilibrium would be a Pareto optimum.
In microeconomics, supply and demand is an economic model of price determination in a market. It postulates that, holding all else equal, in a competitive market, the unit price for a particular good or other traded item such as labor or liquid financial assets, will vary until it settles at a point where the quantity demanded will equal the quantity supplied, resulting in an economic equilibrium for price and quantity transacted. The concept of supply and demand forms the theoretical basis of modern economics.
In mainstream economics, economic surplus, also known as total welfare or total social welfare or Marshallian surplus, is either of two related quantities:
In economics, economic equilibrium is a situation in which economic forces such as supply and demand are balanced and in the absence of external influences the values of economic variables will not change. For example, in the standard text perfect competition, equilibrium occurs at the point at which quantity demanded and quantity supplied are equal.
In classical economics, Say's law, or the law of markets, is the claim that the production of a product creates demand for another product by providing something of value which can be exchanged for that other product. So, production is the source of demand. In his principal work, A Treatise on Political Economy, Jean-Baptiste Say wrote: "A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value." And also, "As each of us can only purchase the productions of others with his/her own productions – as the value we can buy is equal to the value we can produce, the more men can produce, the more they will purchase."
In economics, effective demand (ED) in a market is the demand for a product or service which occurs when purchasers are constrained in a different market. It contrasts with notional demand, which is the demand that occurs when purchasers are not constrained in any other market. In the aggregated market for goods in general, demand, notional or effective, is referred to as aggregate demand. The concept of effective supply parallels the concept of effective demand. The concept of effective demand or supply becomes relevant when markets do not continuously maintain equilibrium prices.
In economics, quantity adjustment is the process by which a market surplus leads to a cut-back in the quantity supplied or a market shortage causes an increase in supplied quantity. It is one possible result of supply and demand disequilibrium in a market. Quantity adjustment is complementary to pricing.
Monetary disequilibrium theory is a product of the monetarist school and is mainly represented in the works of Leland Yeager and Austrian macroeconomics. The basic concepts of monetary equilibrium and disequilibrium were, however, defined in terms of an individual's demand for cash balance by Mises (1912) in his Theory of Money and Credit.
In economics, a shortage or excess demand is a situation in which the demand for a product or service exceeds its supply in a market. It is the opposite of an excess supply (surplus).
In economics, tax incidence or tax burden is the effect of a particular tax on the distribution of economic welfare. Economists distinguish between the entities who ultimately bear the tax burden and those on whom the tax is initially imposed. The tax burden measures the true economic effect of the tax, measured by the difference between real incomes or utilities before and after imposing the tax, and taking into account how the tax causes prices to change. For example, if a 10% tax is imposed on sellers of butter, but the market price rises 8% as a result, most of the tax burden is on buyers, not sellers. The concept of tax incidence was initially brought to economists' attention by the French Physiocrats, in particular François Quesnay, who argued that the incidence of all taxation falls ultimately on landowners and is at the expense of land rent. Tax incidence is said to "fall" upon the group that ultimately bears the burden of, or ultimately suffers a loss from, the tax. The key concept of tax incidence is that the tax incidence or tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply. As a general policy matter, the tax incidence should not violate the principles of a desirable tax system, especially fairness and transparency. The concept of tax incidence is used in political science and sociology to analyze the level of resources extracted from each income social stratum in order to describe how the tax burden is distributed among social classes. That allows one to derive some inferences about the progressive nature of the tax system, according to principles of vertical equity.
Walras's law is a principle in general equilibrium theory asserting that budget constraints imply that the values of excess demand must sum to zero regardless of whether the prices are general equilibrium prices. That is:
In economics, competition is a scenario where different economic firms are in contention to obtain goods that are limited by varying the elements of the marketing mix: price, product, promotion and place. In classical economic thought, competition causes commercial firms to develop new products, services and technologies, which would give consumers greater selection and better products. The greater the selection of a good is in the market, the lower prices for the products typically are, compared to what the price would be if there was no competition (monopoly) or little competition (oligopoly).
The neoclassical synthesis (NCS), neoclassical–Keynesian synthesis, or just neo-Keynesianism was a neoclassical economics academic movement and paradigm in economics that worked towards reconciling the macroeconomic thought of John Maynard Keynes in his book The General Theory of Employment, Interest and Money (1936). It was formulated most notably by John Hicks (1937), Franco Modigliani (1944), and Paul Samuelson (1948), who dominated economics in the post-war period and formed the mainstream of macroeconomic thought in the 1950s, 60s, and 70s.
In economics, an excess supply, economic surplus market surplus or briefly supply is a situation in which the quantity of a good or service supplied is more than the quantity demanded, and the price is above the equilibrium level determined by supply and demand. That is, the quantity of the product that producers wish to sell exceeds the quantity that potential buyers are willing to buy at the prevailing price. It is the opposite of an economic shortage.
Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.
Disequilibrium macroeconomics is a tradition of research centered on the role of disequilibrium in economics. This approach is also known as non-Walrasian theory, equilibrium with rationing, the non-market clearing approach, and non-tâtonnement theory. Early work in the area was done by Don Patinkin, Robert W. Clower, and Axel Leijonhufvud. Their work was formalized into general disequilibrium models, which were very influential in the 1970s. American economists had mostly abandoned these models by the late 1970s, but French economists continued work in the tradition and developed fixprice models.
In microeconomics, excess demand, also known as shortage, is a phenomenon where the demand for goods and services exceeds that which the firms can produce.
This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.